Publication 7
Tauno Tiusanen, Jatta Kinnunen, Sami Kallela
EU’S ENLARGEMENT PROCESS: INVESTMENT CLIMATE IN 10 TRANSITIONAL ECONOMIES
Lappeenranta University of Technology Northern Dimension Research Centre
P.O.Box 20, FIN-53851 Lappeenranta, Finland Telephone: +358-5-621 11
Telefax: +358-5-621 2644 URL: www.lut.fi/nordi
Lappeenranta 2004
ISBN 951-764-912-6 (paperback) ISBN 951-764-913-4 (PDF)
EU’s Enlargement Process: Investment Climate in 10 Transitional Economies
Tauno Tiusanen Jatta Kinnunen
Sami Kallela
Contents
Foreword...2
1. Introduction ...3
2. Welfare and living standard ...9
2.1 Welfare...9
2.2 Living standard comparison and labour costs...17
2.3 Development of labour productivity and employment ...23
2.4 Economic scenario ...28
3. Economic equilibrium ...31
3.1 Transitional economies as forthcoming members of the European Monetary Union ...33
4. Taxation...38
5. Foreign direct investments in the target countries ...43
6. Conclusions...52
Foreword
The Northern Dimension Research Centre (NORDI) is a research institute run by Lappeenranta University of Technology (LUT). NORDI was established in the spring of 2003 in order to co-ordinate research into Russia.
NORDI’s mission is to conduct research into Russia and issues related to Russia’s relations with the EU with the aim of providing up-to-date information on different fields of technology and economics. NORDI’s core research areas are Russian business and economy, energy and environment, the forest cluster, the ICT sector, as well as logistics and transport infrastructure. The most outstanding characteristic of NORDI’s research activities is the way in which it integrates technology and economics.
LUT has a long tradition in making research and educating students in the field of communist and post-communist economies. From the point of view of these studies, LUT is ideally located in the Eastern part of Finland near the border between EU and Russia.
This seventh volume in the series of NORDI deals with welfare and labour markets in Estonia, Latvia, Lithuania, Poland, Czech Republic, Slovakia, Hungary, Slovenia, Romania and Bulgaria. These countries, excluding Romania and Bulgaria have joined the European Union in May 2004.
The authors would like to express their gratitude to the EU’s Interreg IIIA programme, Ministry of Education of Finland and the cities of Lappeenranta, Imatra and Joutseno for their financial support towards NORDI. We also give our sincere thanks to NORDI’s project manager Jari Jumpponen for valuable comments, editing and support.
Lappeenranta, June 2004
Professor, Ph.D. Tauno Tiusanen Director
Northern Dimension Research Centre Lappeenranta University of Technology
Jatta Kinnunen M.Sc.(techn), M.Sc.(econ) Sami Kallela Assistant, Student of Technology Researcher
Lappeenranta University of Technology Lappeenranta University of Technology
1. Introduction
In the epoch of the Cold War, Europe was divided in two parts by the Iron Curtain. On the Eastern side of this dividing line were centrally planned communist economies, while the Western side was applying decentralised market system in running national economies. Both sides had different schemes for economic integration.
One of the very core points in communist ideology was the theory of imperialism. In the Marxist-Leninist dogma it was maintained that the Soviet Union was encircled by hostile imperialist powers. Thus, the Soviet empire created for herself an economic strategy based on autarky. Industrial revolution was carried out by selling primary products to the world market and by buying machines needed for building up industrial base. In this context it is important to note that the former Soviet Union had a high autarky endowment: the vast country had an extremely rich resource base making far-reaching self-sufficiency possible.
In the aftermath of the Second World War, the situation changed radically. As a result of the war, the so-called Eastern bloc became into being, in which all national economies started applying the communist system of central planning. Thus, forced industrialisation took place in countries with modest resource base emulating the Soviet model. The effect was greatly to increase the dependency on foreign trade of what had previously been a predominantly agricultural country (like Hungary, Romania and Bulgaria).
In the late 1940s, the “trading bloc”, called the Council of Mutual Economic Assistance (CMEA, customarily called “Comecon” in the West) was set up in Moscow, comprising the Soviet Union, Bulgaria, Czechoslovakia, East Germany (GDR), Hungary, Poland and Romania. Cuba and Vietnam joined in later. Yugoslavia never became a full member of Comecon.
In the communist system, bureaucratic coordination of the economy was the core. The hypothetical logical extension of this system would have been a supranational centralized command economy in the CMEA-framework. Obviously, the Soviet Union was far the largest CMEA-member and it followed from this recognition of Soviet supremacy that if a supranational planning unit was in need, it could only be the top level of Soviet bureaucracy.
In historical perspective it is important to note that this idea of supranational planning was never carried out. The strict centralization involved would have been incompatible with the autonomy of the participating states, even though that autonomy was limited in any case.
Many observers of the CMEA affairs maintained that the Soviet Union subsidized the import bill of her allies by offering cheap shipments of primary goods. Price guidelines were taken from the world market, which meant that prices used did not necessarily reflect local (Comecon-area) scarcities. Bilateral delivery agreements (between states) were not able to take quality aspects of traded goods optimally into consideration. Almost all observers of the Comecon scene maintained that manufactured goods in intra-Comecon trade were questionable in quality (competition did not exercise pressure on producers to improve technology and quality of exportables).
In the CMEA, a loose framework to foreign trade relations based mainly on bilateral negotiations came into being. In many branches, different CMEA countries set up parallel industrial capacities with the same function, despite all the CMEA´s declarations of principle describing an optimal international division labour. The basic intra-CMEA foreign trade structure was as follows: Soviet Union delivered raw-materials (especially energy-bearers) and the “small Comecon countries” sold investment goods to the Soviets. The ideological goal of the “socialist division of labour” was to establish an autarkic trading bloc independent of the hostile “imperialist” West.
On the Western side of the Iron curtain, two traditional integration models were practiced in the Cold War epoch. The Treaty of Rome (1957) established a Customs Union (The European Economic Community, EEC) with six members: Germany, France, Italy, Belgium, the Netherlands and Luxembourg. European Free Trade Area (EFTA) was established soon afterwards comprising Great Britain and several small West-European countries. These two trading blocs, EFTA and EEC, started to merge in 1973, when three EFTA countries entered the customs union (Great Britain, Ireland and Denmark). After that EEC, which in 1967 took the name European Community (EC), expanded several times. In 1993, EC transformed itself to European Union (EU), which in the mid-1995 had 15 member states.
It is obvious that the economic integration process in the post-war Europe has been far from optimal. The most important background factor in this context is the ideological division of the Old Continent in the Cold War period. Constructing two parallel industrial structures in densely populated continent was not rational from the point of view of general welfare.
Unfortunately, these welfare losses caused by the dividing line of the Iron curtain leading to parallel industrial structures in East and West cannot be measured with any degree of accuracy.
What can be measured, however, is the decline of economic activity in transitional economies (TEs) after the collapse of communism. This historical event took place in two waves: the
“small Comecon countries” (Eastern Bloc) dismantled the central planning and one-party dictatorship in 1989, while the Soviet Union ceased to exist in 1991. Part of that chain- reaction, was also the collapse of the CMEA, the integration body of European communist countries.
It can be realistically stated that the main client of Comecon area exportables was the Soviet Army, or more broadly defined, the military-industrial complex of the Soviet Union. Thus, the countries of the Eastern bloc faced in the early 1990s several problems: a new, geographical orientation had to be found in their export industries. In this restructuring, conversion (turning around military-orientated production units to civilian purposes) was an essential issue. Demand for military hardware withered away alongside with the collapse of the Soviet Union.
It is impossible to estimate, how much the collapse of the Warsaw Pact hurt the former Soviet republics and former Eastern bloc countries. Conversion costs must have been enormous. This burden caused by the conversion was obviously unevenly divided between communist countries. However, in the long run, restructuring of communist bloc economies away from military production toward civilian purposes is obviously welfare enhancing. The mighty build-up of military hardware on the Eastern side of the Iron Curtain was hampering consumer goods output, which were continuously in short supply.
In the epoch of the Cold War, the communist East was not completely isolated from the capitalist West by the Iron Curtain: East-West trade took to a certain extend place. There were limits to Western exports of the highest possible technology: Western powers were not willing to take the risk that technology exchange is used to help communist countries to compete in the military sector. The control of selling investment goods to communist countries was not impeding all trade across the Iron Curtain.
The Soviet Union earned fair amounts of hard currency by selling raw materials (especially energy bearers) to capitalist countries. Other Eastern bloc countries had to sell manufactured goods. Very often the price was a decisive factor: products from the East had normally a price reflecting the prestige (and quality) of their exportables.
In the 1970s, Western banks faced the problem of recycling so called petro-dollars (income earned by oil-producing countries). Centrally planned economies of Eastern bloc were regarded as reasonable risk in credit allocation. In the 1980s, several emerging markets became credit unworthy, among them some CMEA-members. Poland became a case of defaulting. The golden era of financing East-West trade ended before communism collapsed.
The attempt to modernise centrally planned economies with Western credits and machines failed.
In sum, it can be stated that the first years of transition in every post-communist country were extremely difficult. Thus, it was not surprising that TEs suffered a slump after the systemic change. Decreasing GDP (gross domestic product) was combined with strong price hikes, when centrally planned fixed price system was abolished. The gap in living standard between East and West widened in the early years of post-communist transition. However, this period of economic decline remained rather short in those countries of the former Eastern bloc, which applied for EU-membership and were accepted to the Union in 2004.
In the second half of the 1990s, those TEs with accession to EU had a clear catching up process: the living standard gap between East and West (EU) started to decline, because TEs growth performance was better than that in the EU-region. However, the boom period of TEs brought about mixed results on the labour market: work opportunities did not increase rapidly amid strong economic growth. In European Union, economic growth in the 1990s was disappointing and demand for labour dissatisfactory. A new economic term came into being:
euroschlerosis. It refers to labour market rigidities in the welfare states of Western Europe. In this context, it is maintained that the affluent part of Europe is not able to offer optimal investment climate, because of high labour costs and heavy tax burden. Euroschlerosis hints on potential economic stagnation in the old EU-countries (15), if present inflexibilities on the labour market will be maintained.
In the framework of the Eastern enlargement of the EU, an emotional debate has started about the future of the welfare, or social state (which is called “the Scandinavian or Swedish Model”; in continental Europe the same system is called “The Rhineland model”). This system offers extensive public services and thus, high taxes for the population. It is said that internationally mobile capital is trying to avoid high tax locations, which puts the future of the Scandinavian model in danger. Investment outside of the Scandinavian or Rhineland model countries is called “social dumping”. It is often pointed out that the former Eastern bloc offers low wages and moderate taxes in comparison to Western Europe, which endangers welfare
The conventional economic theory maintains that economic integration between two areas will be advantageous for both sides even if there are large gaps in wealth between two regions. Both regions will specialize in production of those goods for which it has a comparative advantage. Economic units from the richer region will start investing in the poorer ones expecting high returns. As a result, increasing quantity and quality of physical capital enhances local productivity in the poorer region, where average wages grow. In this virtuous circle, the demand of higher quality consumer goods in the poorer region will increase affecting positively production in the richer region. In this process, all participants, rich and poor regions harvest welfare gains.
Thus, economic integration is not supposed to be a zero-sum game, in which the rich part of the region is helping the poor part. Cohesion is supposed to be a win-win game creating wealth by investing in economic development in below-average income locations, which enhances economic activity in the above-average income parts of the integrated region.
There is evidence that in the last decades of the 20th century a positive convergence of GDP per capita took place. This convergence between EU member states, notably the catch-up by Ireland, Portugal and Spain, shows that large-scale investment in infrastructure modernisation combined with the opening of markets can advance convergence. However, at the same time there has been within member states certain divergence (widening of regional disparities).
This paradoxical situation has caused fairly high unemployment figures in the EU-sphere during the last two decades. It is said that the European labour market is rigid and inflexible.
That is the content of the new term: “euroschlerosis”. There is the danger that the newcomers (after Eastern enlargement of EU) will contract this disease.
This research report deals with welfare and labour market issues in the new EU-members from the post-communist part of Europe. Cyprus and Malta are excluded. Romania and Bulgaria are included in this research report, even if these two TEs were not able to enter the Union in 2004.
In the first years of the 21st century, unemployment rate in EU has been about 9%. It means that labour force in Western Europe is not optimally allocated. A new constructive strategy to take care of Europe’s resources ought to be created. In the eight new EU-members under review, the labour supply clearly exceeds the existing demand. Living standard in Central Eastern Europe is lower than in the “old” EU-states (15). Labour is rather cheap in nominal and unit labour cost (ULC) terms in the accession countries.
Thus, workers in transitional economics have clear incentive to seek work in the West. This incentive looks extremely strong when living standard differentials in nominal terms are covered. However, there are remarkable differentials also in price levels between the old and new EU-members. This fact must be taken into consideration, when pan-European comparisons in welfare are discussed.
2. Welfare and living standard
2.1 Welfare
“The modern welfare state” is a term, which is used in social sciences and media to describe post-war mixed economies in Europe. It is often maintained that this model clearly differs from American capitalism, in which the public sector involvement is essentially smaller than in Europe.
It is not the aim of this study to discuss differences of mixed economies in the “rich part” of the world. The share of the public sector of GDP is higher in Sweden than in the United Kingdom. Japan and the USA are far behind of the Scandinavian countries in “the welfare state”. It suffices to say here that all “old” EU-countries (15) are welfare states with relatively high public sector involvement.
The mixed economy (welfare states) has two fundamental principles:
- Economic dynamism relies on the market, which is as free as possible with respect to prices and wages. Free market forces are supposed to allocate resources optimally.
- Market forces alone cannot regulate all aspects of society. The public sector must be the guarantor of certain social requirements.
In the framework of this model, the welfare component postulates that the state is responsible for social security in the broadest sense. The market element contains the element of free bargaining on wages between employers and employees.
In the model of mixed economy, it is important that free and open competition is not distorted by strong market powers. Thus, all nation states in EU (15) have established anti-monopoly offices. An EU monopoly authority with strong power has been established, which can impose heavy penalties on enterprises, who abuse their market position.
It is often said that the welfare states up Western Europe provide extensive “free services” in education, health care etc. This statement is fundamentally wrong: no society is able to provide really free services, which in actual fact are all paid for by the public sector. As the
final payers of the free services are the taxpayers, the welfare state has an important role in redistribution of the income earned in the national economy.
Graph 1. Government receipts* as % of GDP
CD.
receipts
he magnitude of the redistribution function of the state can be measured by taking
quivalent figures for transitional economies (TEs) can be calculated by taking GDP figures 25
30 35 40 45 50 55 60
Japan United States
Ireland Australia
Spain Brita
in Canada
New Zeal and
German y Italy
Euro area Netherlands
Belgi um
Austria France
Finland DenmarkNor
way Swed
en
Source: OE
*Tax and non-tax
T
government receipts as percentage of local GDP. The most advanced welfare states are in Scandinavia, as the above table shows. In Sweden, Norway, Denmark and Finland the share of government receipts (as % of GDP) is over 50%. Norway is not a EU-country. The average figure in Euro-area is about 47%.
E
and central budget revenues in local currency. With this simple method, the nature of the
“mixed economy” in the TE-region can be measured.
able 1. GDP and Budget revenue – local currency, billion, 2003
B as % of A T
A B
GDP Bud. revenues
a 5.700 1.974 ,6
Estonia* 106,5 36,1 33,9 Czech Republic 2.340 700 29,9 Latvia* 5,2 1,54 29,6 Hungary 18.300 4.940 27,0 Bulgaria 35.000 8.442 24,1 Poland 804.700 152.176 18,9 Slovakia 1.235 233 18,9 Lithuania* 50,7 9,5 18,7
Romania 1.820.000 214.156 17,7
Russia 13.300 2.342 17,6 WIIW 2/4 (for the Baltic St
Sloveni 34
Source: , Canstat Riga 200 ates).
ove, GDP figures are given in local currency (A figures). Also budget revenue
he highest percentages (budget revenue as % of GDP) can be found in Slovenia (34,6%),
he Czech Republic (29,9%) and Latvia (29,6%), which are also new EU-members, have
ll the other transitional economies in the above table have budget revenues less than 20% of
lovenia is clearly the richest country in the above table with a living standard of about 70%
* in 2002 n the ab I
figures are given in local currency (B figures). Two separate sources are used: WIIW Research Report 303 (February 2004) and Canstat, Riga (2002/4) for the Baltic States (Estonia, Latvia and Lithuania). Government revenues are calculated as a percentage of local GDP.
T
which is the richest TE, and in Estonia (33,9%). In these two countries the public sector share of GDP is roughly one third. Thus, the public sector involvement in these two new EU- member states is essentially below the euro-area average.
T
equivalent figures just below 30%. Hungary with EU-accession is not far away from these two with a 27% figure. Bulgaria with a delayed EU-entry is the next one with a 24,1%
marking.
A
GDP. Poland, Slovakia and Lithuania in this group of countries are new EU-members. In all these three countries budget revenues are roughly 19% of the local GDP. The equivalent figure in Romania is less than 18%.
S
of the EU average (15 “old” EU-countries) calculated by GDP per capita, purchasing power parity (PPP) adjusted in 2003. The equivalent figure in Estonia is considerably lower, only 42,5% (of EU average before the enlargement). Thus, even if Slovenia is considerably better
off than Estonia, these two countries have in relative terms the same public sector involvement. Bulgaria’s budget revenue is with 24,1% (of GDP) relatively high, even though it is the poorest country in the table (with a living standard of less than 30% of the EU average of 15 old members). Bulgaria’s and Romania’s EU-entry is postponed.
The above table shows clearly that there is no obvious positive correlation between living
this context it is appropriate to remark that all transitional economies accepted into EU
he example of Finland shows that the welfare state was created step by step in the post-war
he financing of the welfare state calls for high taxes and social security deductions from standard and public sector involvement (measured as budget revenues as % of GDP) in TE- region. Generally speaking, the percentages are very low, especially in Scandinavian comparison. It can be concluded that transitional economies are not “Scandinavian welfare states”.
In
(Estonia, Latvia, Lithuania, Poland, the Czech Republic, Slovakia, Slovenia and Hungary) met the entry preconditions, the first of which is functioning democracy. According to EU rule, fiscal policy is done on the level of nation state. Thus, it is in the discretion of every new EU state to collect taxes and use state revenues as governments see fit. In the fiscal policy- making, every government must consider the support of the local electors. West-European welfare states have come into being as a result of historical democratic process. Therefore, there is no unified Western system of public sector involvement in the economy.
T
period. Strong economic growth before the 1990s allowed the construction of the high-tax and extensive public sector service society. This structural change was backed by political consensus.
T
gross wages and gross salaries, which increase the price of labour. High cost of labour gives a disincentive to private investment, especially in labour intensive branches. Many traditional industries (manufacturing) are moving out of Western Europe, which is the main cause of high unemployment figures. New, dynamic branches demand better and better-educated skills, while blue-collar work in Western Europe is less and less needed. Increased public spending has increased work in public sector in all Western welfare states. However, this strategy does not mean that a rational use of economic resources can be guaranteed on the long run. A new strategy with a changeover from social and income subsidies towards active measures to get labour market to work is in need.
In the wake of the Eastern enlargement of EU, it was frequently pointed out in Western media that the new members of the Union offer cheap labour with low taxes to international investors. This discussion has not been free of emotions: it is even maintained that the newcomers exercise “social dumping” via unfair competition, in which welfare services are neglected and thus, taxes kept on a low level in TEs.
In a positive scenario it is maintained that the enlarged Union will create new dynamism in the Old Continent by evening out living standard differentials, together with harmonizing price levels and also social security systems. The integration process will thus have positive economic gains beneficial to the Union as a whole.
One of the declared aims of the EU is to close the living standard gap in the economic competition with the US. It is a well-known fact that US living standard is higher than that in EU, where income distribution is more even than in the United States.
Productivity rankings are an important factor in per capita income. Yet, while many EU- countries are on a par with US productivity levels, they are far behind in per capita income. In 2002, EU productivity was on average 92% of the US level, but per capita income was just 72%. Productivity accounted for just 8% of the 28-percentage point difference. Of the remaining 20% point gap roughly 75% was associated with fewer working hours. The other 25% came from lower participation rates, i.e., lower employment relative to the total population and involved differences in such things as retirement ages (they are earlier in Europe) and unemployment rates (higher in Europe). Thus, European countries ought to reduce unemployment and introduce more flexibility into labour markets (greater participation of women and more part-time work, for example). Europeans generally work fewer hours per employee than in most other countries (long holidays, frequent sick-leave etc.). Per capita income is thus directly linked with quality and quantity of work performed in different societies (for details, see: The Conference Board; Research report: Performance 2002. Productivity, Employment and Income in the World’s Economies. New York, 2003.).
Obviously, there is no universal system of social values. One nation may appreciate free time more than another. This may be the case also in the personal level. Thus, the highest possible material living standard is not necessarily an ultimate aim of everyone.
In the communist epoch, it was obvious that Western visitors in the East with their “hard currency” were envied by locals. Thus, catching up with the West in living standard has clearly been an objective of the majority of people living in post-communist societies. It is
widely believed that pan-European economic integration will help to achieve this aim.
Therefore, EU accession was accepted by huge majorities in TEs before the 2004 enlargement.
In the “pre-enlargement period”, there was still a clear gap in living standard between East and West in Europe. This can be illustrated by gross domestic product (GDP) figures per capita calculated in euro.
Table 2. GDP per capita, 2003 (Euro-based)
A B B/A GDP nominal GDP at PPP ERDI
Slovenia 12.407 16.874 1,36 Estonia 5.520 10.322 1,87
Hungary 7.140 13.423 1,88
Czech Republic 7.214 14.211 1,97
Poland 4.801 10.227 2,13
Slovakia 5.524 12.098 2,19 Lithuania 4.592 10.287 2,24 Latvia 3.874 9.219 2,38 Bulgaria 2.292 6.898 3,01 Romania 2.286 6.926 3,03
Greece 17.846
EU-average (15) 24.279 Source: WIIW.
In the light of the “original” GDP per capita figures, there is a very deep gulf in living standard between the new (TEs) and old (15 countries) EU-members. The level reached in the Czech Republic and Hungary is less than one third of that in the “old” EU-members (on average). Bulgaria and Romania, which did not get the EU-accession in 2004, seem to have living standard of only one tenth of the EU (15) niveau.
Evidently, the original GDP figures (marked with A) have biases caused by official exchange rates, which reflect different price levels in an extremely imperfect manner. Therefore, it is appropriate to use a special tool called the purchasing power parity (PPP) adjustment, in order to reach more realistic figures (marked with B). In this adjustment the fundamental fact of relatively low prices in TEs is taken into consideration: PPP corrected figures give a more realistic picture of living standard differentials between East and West than the “raw” figures.
In all TEs in the above table, the PPP adjusted figures (B) are higher than the original GDP numbers indicating that all currencies in TEs are undervalued. After the PPP correction, TEs show still lower welfare than the EU (15) average. However, the gap is essentially more
modest than in the light of the original GDP per capita figures calculated by using official exchange rates.
By dividing the B-figures by A-figures, exchange rate deviation indexes (ERDI) can be established showing, how much the official exchange rate in each TE deviates from the
“equilibrium rate”. In the Polish case, the ERDI value is about two, which means that every euro buys about twice as much goods and services in Poland in comparison to euro-area (on the basis of an average consumer goods basket). Other way around, it can be maintained that prices in Poland are about 50% cheaper than in the euro-region. The low price level (undervaluation) in TEs gives price competitiveness to transitional economies: this is also called “exchange-rate protectionism”. ERDI value, which is the higher, the lower the development level of the economy is, measures the degree of this exchange rate protectionism: it gives price competitiveness to exportables and keeps importables relatively expensive (calculated in local currency). ERDI-values are commented in detail below.
Table 3. Exchange rate deviation index (ERDI), EUR based
Country 1996 2000 2003 Growth %
1996-2003 Growth % 2000-2003 Slovenia 1,45 1,45 1,36 -6,2 -6,2
Estonia 2,44 2,08 1,87 -23,4 -10,1
Hungary 2,37 2,23 1,88 -20,7 -15,7
Czech Republic 2,69 2,30 1,97 -26,8 -14,3 Poland 2,27 2,03 2,13 -6,2 4,9
Slovakia 2,52 2,44 2,19 -13,1 -10,2
Lithuania 3,40 2,30 2,24 -34,1 -2,6 Latvia 3,03 2,18 2,38 -21,5 9,2 Romania 4,90 3,32 3,01 -38,6 -9,3 Bulgaria 4,20 2,92 3,03 -27,9 3,8 Source: WIIW.
In the above table there are growth percentages of ERDI values in the long term and short term. As mentioned above, ERDI has the tendency to be the higher, the more primitive the local economy is: price level has the tendency to be lower in poor countries than in the rich ones. This fact is obvious in the above table: Slovenia, which is the best-off TE in the comparison, has a moderate ERDI figure, only 1,36. Both Bulgaria and Romania with low living standards have an ERDI over three (in the light of 2003 figures).
ERDI values have diminished in TEs during last years, during which TEs have been able to narrow the welfare gap with the West. It means that the undervaluation advantage (in competitiveness) of TEs is eroding with time. It means in actual fact that price level differences between TEs and EU-countries have a tendency to decrease. However, this
erosion of “ER protectionism” has not caused a serious current account (CA) crisis in any of TEs lately.
As pointed out above, the three Baltic States have improved their relative position pretty rapidly in living standard comparison. Thus, it is no wonder that ERDI value has diminished rapidly between 1996 and 2003 in Estonia, Latvia and especially in Lithuania, where ERDI went down by over 34%. It is rather surprising that a similar ERDI improvement have taken place in Romania (about 39%) and in Bulgaria (about 28%) even if these TE’s relative position in living standard comparison deteriorated.
On the other side of the scale, Slovenia has a very moderate ERDI value decrease of only about 6% between 1996 and 2003. This richest country of the group does not need strong undervaluation of her currency, and thus ERDI values in both years (1996 and 2003) are on a very moderate level. In Poland decrease in ERDI has also been 6 percent in the same period, even though her currency is much more heavily undervaluated than in Slovenia. Slovakia (- 13%) shows relatively small ERDI change in seven years. However, it had still relatively high ERDI figure (2,19) in 2003.
In the Czech Republic ERDI value has dropped by 27% and in Hungary by 21% in 1996–
2003. In the last three years they show the best development of the TEs with over 14% ERDI decrease. Between 2000 and 2003 Estonia, Slovak Republic and Romania have each ERDI decrease of 10%. In the same time period, ERDI has actually increased in three TEs. In Latvia undervaluation has increased over nine per cent. Poland has experienced ERDI increase of almost five per cent and in Bulgaria ERDI has risen almost four per cent.
It is worth underlining that all calculations here are Euro-based. Dollar-based ERDI calculations would be considerably different.
Evidently, there is an urgent need in the post-communist countries to give leeway for private consumption after decades of shortages determined by central planners. From this point of view, it is understandable that the overall tax burden in TEs is lower than in the “welfare states” of Western Europe. By definition, it is rather difficult to extract as much taxes from TE-citizens as from Westerners who are better off (in general living standard terms) than EU- newcomers. TEs must find a reasonable balance in their mixed economies: too much redistribution through the public sector may hamper economic growth.
It is not necessarily easy to find a long-term balance between various sectors in TEs. Human capital is becoming a more and more decisive factor in economic growth, which means that every society must pay attention to education. The public sector in the “old” EU-countries invests in this sphere plenty of money, which is one of the decisive factors of high taxes.
Well-functioning infrastructures cannot be created and maintained by minimizing tax burdens. Thus, there is obvious pressure in all TEs to increase the share of the public sector of GDP. This can hardly take place without enhancing the state’s income alongside with economic growth in TEs.
2.2 Living standard comparison and labour costs
In the communist period, it was difficult to compare living standards in different economic systems. Statistics were not necessarily comparable. Obviously, this problem does not exist any more in the period of post-communism.
In the early period of transition, it was rather usual to take GDP or GNP figures per head calculated mainly in US dollars at the going exchange rate in living standard comparisons between East and West. With this method, the gulf in welfare looked very deep.
The result of this all-too-common procedure is to grossly exaggerate the differences in real income between rich and poor. The correct basis of comparison involves GDP figures per capita at current PPPs (purchasing power parity), which are easily available, for example, from The Vienna Institute of International Economic Studies (WIIW).
Transitional economies are occasionally called emerging markets which normally have undervalued currencies. Undervaluation of a currency is occasionally also called “exchange rate protectionism”: low value of a currency helps price competitiveness of exportables and makes imports expensive (calculated in local money). In the 1990s, all TE-currencies were grossly undervalued.
From the pan-European integration point of view, there are two extremely positive development trends. Firstly, TEs with EU candidacy have been catching up with the West in living standard. Secondly, the exchange rate deviation index (ERDI) has decreased quite clearly since the mid-1990s. The growth of living standard is shortly analysed below.
Table 4. GDP per capita at current PPPs (EUR), European Union (15) average=100
1995 2000 2003
Slovenia 64 69 70
Czech Republic 62 59 59
Hungary 45 50 55 Slovakia 45 49 50
Estonia 33 40 43
Lithuania 28 35 42
Poland 35 39 42
Latvia 24 30 40
Romania 32 23 29 Bulgaria 28 29 28 Source: WIIW.
In the table above, the EU (15) average living standard (PPP adjusted, euro-based) is marked with 100. In the mid-1990s the gap in well-being between East and West was rather deep, but, improvement has generally taken place with three exceptions. In Romania the figure in 2000 was lower than in year 1995 and 2003. Bulgaria, shows no improvement from 1995 to 2003.
The most dramatic living standard improvement has taken place in the Baltic area, where the relative living standard has shown over ten-percentage point improvement between 1995 and 2003. Living standard has grown 10 percentage points in Estonia, 16 percentage points in Latvia and 14 percentage points in Lithuania (in comparison to EU of 15).
Slovenia has the highest living standard in the TE-group: her relative figure was 64% in 1995 and 70% in 2003 showing a 6 percentage points growth. The second wealthiest TE on the table, the Czech Republic, has experienced negative development: the living standard in 1995 was 62% of EU-15 average, but it declined to 59% in 2000. In 2003 her GDP/capita-figure stayed at the year 2000 level.
Living standard in Hungary has grown by 10 percentage points in EU-comparison between years 1995-2003. Poland has increased her relative well-being by 8 percentage points at the same period of time. Slovakia has increased her living standard by 5 percentage points between 1995 and 2003.
The living standard gap between the best TE on the table (Slovenia) and the poorest one (Bulgaria) is strikingly high. Slovenia’s well-being is over two thirds of the EU level, while Bulgarians and Romanians are not able to reach even one third of the EU standard.
In the early period of transition, every single TE suffered from an economic slump. This is understandable, because in central planning many unprofitable activities took place. Thus, it
Poland was the first TE with resuming economic growth. With a recovering economy (since 1992) an investment boom started. Poland has been the strongest “economic tiger” of the TE- region, in which no universal picture of economic dynamism can be observed.
Table 5. GDP development in selected TEs
2003 (Index 1990 = 100) 2003
(Index 1995 = 100)
Poland 152,0 136,4
Slovenia 129,9 133,8
Hungary 119,3 134,6
Slovakia 116,6 134,9
Czech Republic 109,5 115,0
Estonia 103,6 149,9
Romania 97,7 108,8
Bulgaria 92,4 109,4
Lithuania 87,0 150,1
Latvia 78,6 158,4
Source: WIIW.
In the first index of the table above, the base year is 1990. In the transitional period, the Polish economy has grown by over 50%, while the next best performance is much lower (29,9% in Slovenia). In many TEs, there has been economic decline since 1990. Latvia and Lithuania have figures below one hundred. Also Bulgaria and Romania show less than 100 pointing to economic decline since 1990.
The base year of the second index is 1995. The figures of this index show that economic growth has resumed in all countries involved: all index numbers are over hundred. However, growth figures are strongly dissimilar.
Since the mid-1990s, the three Baltic countries, Estonia, Latvia and Lithuania show the strongest trend. Estonia had increase of almost 50%, Lithuania over 50% and Latvia almost 60%. Hungary, Poland, Slovakia, Slovenia show all over 30% growth. Bulgaria and Romania have both a very modest economic growth of 8-10% between 1995 and 2003.
Economic aggregates (GDP, GNP) never give a full picture of living standard on personal level. Therefore, it is appropriate to compare wage levels in TEs. Average gross wages in TEs calculated in euros are easily available.
Table 6. Average gross wage/month (EUR)
1996 2000 2003 Growth (%) 1996-2003 Growth (%)
2000-2003
Slovenia 762 935 1.085 42 16
Hungary 245 337 544 122 61 Czech Republic 289 382 532 84 39 Poland 259 472 499 93 6 Estonia 198 314 431 118 37 Slovakia 212 268 346 63 29 Lithuania 123 274 311 153 14
Latvia 143 267 299 109 12
Romania 110 144 180 64 25 Bulgaria 60 115 144 140 25 Source: WIIW.
In the 7-year period covered in the above table, wage increases can be in many TEs called as frog leaps. The steepest hike took place in Lithuania, where wage grew by more than 150 percent between 1995 and 2002. Bulgaria has the second fastest growth of 140% and the third fastest growth performer was Hungary (122%). The average monthly earning in Lithuania (2003) was, however, over double (€ 311) of that in Bulgaria (€ 144), which is the worst earner in the table.
In the same period, Estonia and Latvia more than doubled their earning level. Poland almost doubled her gross wage level. In 2003 the Czechs, the Poles and the Hungarians earned clearly more than the citizens in the Baltic States.
In 2003, Slovenia was far ahead in the wage scale with a monthly pay of more than € 1.000.
In the richest TE, wage growth in 1996–2002 was relatively moderate, 42% only.
Romanians are the second worst earners in the table with rather modest growth rate (64%
respectively). Slovakia has a modest average income of € 346 a month with rather modest growth of 63% in seven years.
The difference between the best wage, in Slovenia, and the lowest pay (Bulgaria) is striking:
Slovenians earn over 7,5 times more than Bulgarians when nominal wage is considered.
Average gross pay in Finland in 2002 was about € 2.200 a month.
It was stated above, that the difference in nominal wages between Bulgaria and Slovenia is factor 7,5. In the real wage comparison (nominal wage x ERDI) this difference decreases to factor 3,4. This is due the lower price level in Bulgaria compared to Slovenia. Obviously, no comparisons of real living conditions can be made without using ERDI corrections.
Table 7. Average real wage/month (nominal wage x ERDI, in Euros)
1996 2000 2003 Growth
(%) 1996-2003
Growth (%) 2000-
2003
Slovenia 1.102 1.359 1.476 34 9
Poland 589 957 1.065 81 11 Czech Republic 777 880 1.047 35 19 Hungary 582 751 1.022 76 36 Estonia 483 653 807 67 24 Slovakia 534 655 757 42 16 Latvia 434 583 711 64 22 Lithuania 420 605 696 66 15 Romania 464 420 545 17 30 Bulgaria 294 381 434 48 14 Source: WIIW.
When ERDI is taken into account, Slovenia is still the highest earner of TEs (€ 1.476).
However, the difference to Poland, Czech Republic and Hungary is not as large as in nominal wage comparison. All of these countries have average monthly real wage over thousand euros. Bulgaria and Romania are still the lowest earners, but the difference to Baltic States is much lower than in nominal wage comparison.
Poland has the highest growth (81%) in the period of 1996-2003. Hungary has also increased her real wage level tremendously (76%). The Baltic States have more moderate growth rates (64-67%) at the same time period. When the lowest earners (Bulgaria and Romania) are compared, it can be seen that Romania has a very low growth (only 17%), when Bulgaria has a growth rate of 48 percent. It is actually higher than the real wage growth in the Czech Republic (35%), Slovakia (42%) and Slovenia (34%). In the last three years Hungary (36%) and quite surprisingly Romania (30%) have had the best development in their real wage levels. Estonia and Latvia are in the second group with over twenty per cent growth rates.
Slovenia with the highest earnings level has only 9 percent growth in 2000-2003.
In investment calculations multinational companies compare unit labour costs (ULC) in various locations. This indicator is more important than the nominal wage. Naturally, ULC may play a decisive role when labour intensive activities are relocated.
WIIW publishes ULC figures, PPP adjusted in index form, in which Austria equals 100.
Using this data, ULC development in TEs under review can be analysed.
Table 8. Unit Labour Costs (PPP adjusted), Austria=100
1996 2000 2003 Growth
(%) 1996-2003
Growth (%) 2000-2003 Slovenia 56 62 65 15,7 4,8
Estonia 32 39 46 44,6 16,5
Poland 33 51 45 38,7 -11,2
Czech Republic 25 33 41 60,5 25,2
Hungary 23 29 41 79,5 43,2
Latvia 24 37 35 44,7 -6,0
Lithuania 20 33 32 54,9 -4,7
Slovakia 25 27 31 25,5 14,3
Romania 22 33 29 31,0 -10,8
Bulgaria 11 19 20 84,9 8,8 Source: WIIW.
Unit labour costs in TEs were in Western comparison generally very low in the mid-1990s.
Thus, labour intensive activities were obviously attracted to the TE-region. From the investors’ point of view, the scene has changes rather rapidly during last years: ULC in TEs show steep increase. Obviously, this delivers a strong background factor for the deterioration of the employment: rapidly increasing labour costs per production unit do not favour creation of new working places.
The fastest ULC growth is registered in the above table in Bulgaria, where costs of labour per production unit (in relative terms) grew by 85% from 1996 to 2003. In the shorter timescale (2000–2003) the growth is only about 9 percent, which means that most of the ULC growth has happened between years 1996 and 2000. In the year 2003 Bulgarian ULC level was, however, only one fifth of Western (Austrian) level. Romania has also very low ULC level compared to Austria (about 30%). The ULC growth in Romania has been very moderate between years 1996 and 2003 and in the last three years the ULC has actually decreased by 11 percent in the comparison with Austria.
In the same table Hungary shows a 80% growth in her ULC figure in the last seven years. The table shows however, that the growth is mostly from the last three years. The richest TE under review, Slovenia offers unit labour costs, which is only 35% below the Austrian level. The ULC growth has been very moderate in Slovenia. The Czech Republic has experienced notable increase (60,5%) in her ULC figure between 1996 and 2003 and the growth is quite evenly distributed between the two timescales. Estonia seems to be the most expensive Baltic State in ULC terms. Her ULC level is a bit under a half of the Austrian ULC. Latvia and Lithuania have cost level about a third of the Austrian level. Their ULC has grown at the average rate of TEs in the last seven years, but in the recent years (2000–2003) the trend is
Poland was in ULC comparison on the second place (after Slovenia) in 2000 making the country an expensive production location. However, Poland has experienced the most dramatic ULC decrease in the table: between the years 2000 and 2003 Poland’s ULC level has dropped over 11%. In 2003 her ULC was at the Estonian level, about 45% of Austrian unit labour cost. Slovakia shows quite moderate ULC level (about the same as in Lithuania, 31%). Also Slovakia’s ULC growth is low, a bit over 25% in 1996–2003.
In the list of TEs, Bulgaria offers the most convenient ULC: about 5 Bulgarians can be employed with the price of one Austrian (using ULC as a basis of calculation). In Romania the equivalent figure is a bit more than 3.
2.3 Development of labour productivity and employment
Obviously, the most important background factor in the improvement of living standard is productivity. The figure 3 below shows development of productivity in manufacturing sector of the TEs.
Graph 2. Labour productivity in manufacturing (1995=100)
80,00 100,00 120,00 140,00 160,00 180,00 200,00
Estonia Latvia
Lithuania Poland
Czech Republic Slovak Republic
Hungary Slovenia
Bulgaria Romania
1995 1996 1997 1998 1999 2000 2001 2002
Source: WIIW Industrial Database.
The productivity improvement in Poland and Hungarian manufacturing has been striking between 1995 and 2002: manufacturing productivity has almost doubled in these countries.
Slovakia is not far behind with a growth rate of almost 80%. Czech Republic is also a good performer with a 60 percent growth from 1995 to the year 2002.
The Baltic States have experienced fairly good productivity growth in their manufacturing sector. Estonia has the fastest growth with over 60% growth rate (by the year 2000) and competes with Hungary and Poland to be the best TE in the graph. Lithuanian growth rate is under 40% (by the year 2000) and Latvia lies between these two with over 50% growth (2001). Manufacturing productivity has risen steadily in the Baltic States, except the year 1999 in Lithuania. However, the last year in Estonian and Lithuanian time series is 2000. This should be noted, when comparisons are made.
Productivity growth in Slovenia is steady, but with only minor annual steps. Growth between years 1995–2002 has been only 20%, which is very low compared to other TEs on the table.
Only in Bulgaria the development has been even more modest than that.
Bulgaria is at the bottom of the scale with only minor improvements compared to year 1995 level. Bulgarian manufacturing productivity has practically not developed at all between the years 1995–2002. In fact, Bulgaria experienced negative development between 1995 and 1997. Romania has experienced a 40% growth between 1995 and 2003, which is better than the development in Slovenia. Romania has also experienced a negative growth period in 1996–1998, but from the year 2000 her manufacturing sector has shown serious productivity growth. Overall, manufacturing productivity development in TEs under review shows very encouraging trends.
Labour market trends in TE-region have some rather odd features. Even if there has been a strong boom in CEECs since the mid-1990s, unemployment shows an increasing tendency.
However, in this sphere development has been rather uneven.
Table 9. Unemployment
In 1000 persons Rate (%)
1995 2000 2003 1995 2000 2003
Poland 2.629 2.785 3.347 14,9 16,1 20,0 Slovakia 333 485 460 13,1 18,6 18,0 Bulgaria 424 567 461 11,1 16,9 14,5 Lithuania .. 276 210 .. 15,4 12,7 Latvia 83 159 125 6,6 14,5 10,8 Estonia .. 90 65 7,6 13,6 10,0 Czech Republic 153 455 399 2,9 8,8 8,1 Romania 998 821 740 9,5 7,1 8,0 Slovenia 127 68 64 14,5 7,0 6,7 Hungary 496 263 245 11,7 6,4 5,9 Source: WIIW, Bank of Estonia, Central Statistical Bureau of Latvia and Statistics Lithuania.
Estonia had 65.000 unemployed people with an unemployment rate of 10% in 2003. The
Lithuania. Thus, in the Baltic States some 400.000 people were out of work in 2003. In the time period 2000–2003 the Baltic States have shown positive development in their unemployment rates: in Estonia the rate has dropped 3,6 percentage points, in Latvia 3,7 percentage points and in Lithuania 2,7 percentage points.
Hungary and Slovenia show similar positive tendencies: both countries have been able to roughly halve the number of unemployed persons and the unemployment rate between 1995 and 2003.
In the Czech Republic unemployment rate in 2003 was rather modest, only 8,1%. However, the rate has more than doubled since 1995. Unemployment rates in 2003 were on critically high level in Poland (20,0%), Slovakia (18,0%) and Bulgaria (14,5%). All these TEs show a strongly increasing tendency in unemployment rate since 1995.
Especially strong increase in unemployment has taken place in Poland where amid an economic boom the number of unemployed people increased by almost one million.
Altogether, over 6 million people were out of work in CEECs in 2003. Over half of them live in Poland and about 1,2 million of them live in Bulgaria and Romania.
In the Baltic States about 400.000 people were unemployed. Thus, in EU accession countries there were about 5 million people out of work. In 2003 the unemployment rate of eight TEs with EU accession was 11,5%.
In the light of these labour market figures it can be assumed that there will be plenty of challenges in the pan-European integration to create new working places in the old and new EU member countries. No easy solutions are in sight.
At the EU summit meeting in early 2000 in Lisbon, an ambitious reform programme was set in motion. One of the objectives of this long document is raising employment levels in the EU-members from around 60% (in the late 1990s) to 70% of the working age population by 2010 (for details, see: World Economic Forum: The Lisbon review 2002-03).
In this respect, some progress has taken place in the EU, where the average figure in 2002 was about 64%. In the US, about 10% more of working age population was employed.
Equivalent figures in the new EU-countries, as well as in Bulgaria and Romania, are in average lower.
Table 10. Employment rates in 2002 (% of working age population)
Bulgaria 51,1
Poland 51,7
Hungary 56,5
Slovakia 56,5
Romania 58,6
Latvia 60,5
Lithuania 60,6
Estonia 61,7
Slovenia 64,3
Czech Republic 65,6
EU (15) average 64,2
Source: Eurostat, EU labour force survey 2002.
As the table above shows, the Czech Republic has 65,6% of the working age population employed. This is somewhat higher figure than the EU (15) average. Slovenia is virtually on the same level as EU (15) average.
Some figures in TEs are really very low. Only about half of all people between 15 and 65 years of age have a job in Bulgaria and Poland. Slovakia and Hungary have exactly the same figure of 56,5% of working age population active. Latvia and Lithuania have equivalent figures of just over 60%, while Romania remains below this percentage with 58,6. Estonia has the highest marking in the Baltic States with 61,7%.
The best-scoring TEs in the above table are the best-off new members of EU (in living standard). Bulgaria has the lowest participation figure, as well as the most modest living standard in countries under review. In Poland, the share of active population is amazingly low. It can be concluded that there is a positive correlation between living standard and the participation rate: the higher the share of active part of population, the better is the well-being.
However, this correlation is not perfect.
It is a well-known fact that labour force in post-industrial societies is not a homogeneous mass. Amid high unemployment in Western Europe, there has been in many national economies shortage of “human capital”. This factor of production is becoming more and more decisive ingredient of economic growth in the information society.
Obviously, “human capital” is difficult to define. Frequently, it is pointed out that there is a shortage of skill, especially in engineering. In the last decades of the 20th century, the shortage of skill was alleviated in the rich part of the world by importing engineers from emerging
markets. From the emerging markets point of view this movement of skill is normally called
“brain drain”.
Amid development of the information society, “brain drain” has certainly taken place, but new forms of using skill have started to emerge. Many multi-national companies started to move R&D activities and software centres to emerging markets. Especially India became a location of highly educated people employed by MNCs.
It is a rather well known fact that there is a large pool of engineers in TEs, because the previous system (central planning) underlined mathematics, natural sciences and engineering.
This resource ought to be optimally used in pan-European framework.
Graph 3. Gross income of engineers per year in 2003, in USD
0 10000 20000 30000 40000 50000 60000 70000 80000
New York Tokyo
Helsinki Paris
London Brussels
Bud apest
Ljubljana Buc
harest Wars
aw Prague
Vilnius Tallinn
Bratislava
Riga Sofia Moscow
Source: UBS Prices and Earnings 2003.
Naturally, engineers have above-average income in all societies. The gross pay of an engineer in New York in 2003 was about $ 75.000 and in Tokyo over $ 70.000 a year. In Helsinki the gross income of engineers was almost $ 50.000 a year. The equivalent figure in Paris, London, and Brussels was roughly $ 40.000. In comparison, engineers in Budapest and Ljubljana (about $ 15.000), Warsaw, Prague and Vilnius ($ 10.000 in each) are very advantageous from the point of view of employers. In the countries under review, the gross income of engineers was lowest in Sofia, under $ 5.000 a year. In Moscow the income of
engineers is even lower, about $ 3.500 a year. Surprisingly, engineers in Bucharest (Romania) earn more than their colleagues in Warsaw or Prague.
In this salary comparison, PPP adjustment is necessary to be made. TE-figures ought to be multiplied by about factor two corresponding to ERDI values in TEs. Engineers working in capital cities of TE-countries enjoy a relatively convenient price level in their living costs.
In addition, relatively well-paid specialists in Western Europe face high personal income tax rates. It can be assumed that deductions from gross pay packages are higher for western than eastern engineers.
When these two important factors – low price level and advantageous tax rates – are taken into consideration, it is not self-evident that engineers in TEs have strong incentive to move to
“old” EU-countries. At the same time, Western high-tech companies can potentially achieve considerable cost savings by employing engineers in TEs, because of the advantageous gross salary level. Thus, it is not surprising that a multitude of international companies employ educated and skilled people in TEs in a wide range of activities. Relatively cheap blue-collar work in TEs is obviously becoming less and less important from the FDI point of view, while the human capital aspect is getting increasingly decisive. Several multi-national companies in TEs have established working relations with local universities, in order to be able to select suitable graduates to be used locally.
2.4 Economic scenario
Economic scenario shown in the graph 4 is based on the WIIW growth predictions with annual 4% GDP/capita (purchasing power adjusted) growth. This growth rate is quite close the average growth rates in TEs in the last ten years.
Graph 4. GDP per Capita (PPP), Growth Rate 4% p.a.1
Es toni a La tvi a
Lith ua nia Po lan d
Cz ech Slo vak
Hu ng ary Slo ven ia
Bu lga ria Ro ma nia
1995 1999 2000 2001 2002 2003 2004 2005 2006 2010 2015
EU-15 (1995) Greece (2003) 17,500 EUR
Germany, EU-15 (2003)
24,000 EUR
Greece (1995) 11,500 EUR
Source: WIIW.
By the year 2015, the richest TE Slovenia, will catch up European Union current (2003) level.
With an annual growth rate of 4% Slovenia’s purchasing power adjusted GDP per capita will in 2015 be over 26.700 euros. By the end of year 2004, Slovenia will catch up the GDP/capita level, which the fifteen EU-member states had in 1995. This means, that Slovenia’s living standard matches with the poorest EU-member, Greece’s current level.
Czech Republic comes close to the EU’s current level with 22.600 € in 2015. It will have a higher living standard in 2010 than the 15 EU “old” member states had in average in the year 1995. Hungary is not far behind the Czech Republic and it will also get to the EU-15 (1995) level or Greece’s current (2003) level in 2010. Slovakia, Czech Republic, Hungary, and Slovenia were already in 2003 well beyond the GDP/capita level of Greece, when she joined EU.
1 In this GDP per capita (PPP) growth scenario it has been assumed that all 10 countries under review will have annual growth of 4% for the period 2004-2015.
The third group in the above graph comprises the Baltic States and Poland. Estonia and Lithuania will reach the EU-15 (1995) level in the year 2015 with the projected 4% annual growth. It will take more time for Poland and Latvia to get on that living standard level.
However, according to WIIW prediction, Poland, Estonia and Lithuania will reach the Greece’s 1995 living standard in the year 2004. Latvia will reach that level in 2006.
The lowest living standards in the above graph belong to Bulgaria and Romania. They are far behind other TEs and with 4% annual growth they could get to the Greece’s year 1995 living standard level in the year 2015. These countries have huge living standard gap to catch up even to poorest current EU-member. The difference to EU-15 average is more shocking; it will take at least 20 years to get to Greece’s current (or EU-15 average in 1995) living standard level. With higher growth rate the catching up would naturally take place sooner.
3. Economic equilibrium
General economic equilibrium has gradually improved in European Union accession countries. For considering the changes over the years, consumer price inflation, current account and budget balance are scrutinized.
Table 11. Consumer Price Inflation (annual change %)
1997 1998 1999 2000 2001 2002 2003 Lithuania 8,9 5,1 0,8 1,0 1,3 0,3 -1,2 Czech Republic 8,5 10,7 2,1 3,9 4,7 1,8 0,1 Poland 14,9 11,8 7,3 10,1 5,5 1,9 0,8 Estonia 11,2 8,2 3,3 4,0 5,8 3,6 1,3 Bulgaria 1058,4 18,7 2,6 10,3 7,4 5,8 2,4 Latvia 8,4 4,7 2,4 2,6 2,5 1,9 2,9 Hungary 18,3 14,3 10,0 9,8 9,2 5,3 4,7 Slovenia 8,4 7,9 6,1 8,9 8,4 7,5 5,6 Slovakia 6,1 6,7 10,6 12,0 7,1 3,3 8,5 Romania 154,8 59,1 45,8 45,7 34,5 22,5 15,3 Source: WIIW.
The progress on inflation reduction has been highly satisfactory in the most TEs. The Table 11 shows that inflation is under control in TEs except in Romania where inflation was 15,3 percent in 2003. For example, Lithuania even has deflation in 2003 (-1,2%) and both Poland and Czech Republic have inflation rates under one percent. Slovakia has fairly high inflation (8,5%) in 2003, but in preceding year it was only 3,3%. The exceptionally high inflation figure for Slovakia was due to increases in indirect taxes as well as acceleration of the food price dynamics. Also Hungary and Slovenia show relatively high inflation rates in 2003.
However, considering the inflation level in 1995, every TE has dramatically improved their consumer price stability by the year 2003.
Table 12. Current Account (% of GDP)
1997 1998 1999 2000 2001 2002 2003 Slovenia 0,3 -0,6 -3,5 -2,8 0,2 1,4 0,2 Slovakia -8,5 -8,9 -4,8 -3,5 -8,4 -8,0 -1,3 Poland -3,0 -4,2 -7,5 -6,2 -3,9 -3,6 -1,9 Lithuania -10,2 -11,9 -11,9 -6,0 -4,8 -5,3 -5,7 Romania -6,0 -7,0 -4,0 -3,7 -5,5 -3,4 -6,2 Czech Republic -6,7 -2,2 -2,7 -5,3 -5,7 -6,4 -6,4 Hungary -1,4 -4,7 -5,1 -6,2 -3,4 -4,0 -6,6 Bulgaria 10,1 -0,3 -4,8 -5,6 -6,1 -4,9 -8,9 Latvia .. -10,6 -9,8 -6,9 -9,6 -7,6 -8,9 Estonia -12,1 -9,2 -4,7 -5,8 -6,0 -12,3 -14,6 Source: WIIW.
Current accounts (CA) in TEs under review are mostly on deficit side. In the year 2003 all TEs had CA deficit, excluding Slovenia with a 0,2% surplus. Estonia has the greatest CA deficit with 14,6% of GDP in the year 2003. The other Baltic States, Latvia and Lithuania, have also very high CA deficits. Obviously, Estonia must pay special attention to bring her CA deficit down.
In Slovakia CA deficit in 2003 was on a very low level (-1,3%) compared to the previous years. Czech Republic has been on the same CA deficit level (around 6%) for several years.
Hungary’s current account deficits show an increasing trend lately. Quite an opposite case is Poland, which shows decreasing trend. Poland’s CA deficit in the year 2003 was 1,9%, which is very low, compared to other TEs. Only Slovakia has experienced better progress in her current account.
Bulgaria and Romania show negative development in their CAs: their deficits have been smaller in the past. These two countries need more export intensive production (FDIs) in order to bring the current accounts into equilibrium.
Table 13. Budget Balance (% of GDP)
1997 1998 1999 2000 2001 2002 2003 Estonia 2,0 0,0 -5,0 -1,0 0,0 1,0 ..
Bulgaria -3,6 1,3 1,9 -0,7 -2,2 0,0 -0,3 Czech Republic -0,9 -1,6 -1,6 -2,3 -3,1 -2,0 -4,7 Lithuania -1,0 -1,3 -0,3 -1,7 -1,5 -2,2 ..
Slovenia -1,2 -0,8 -0,6 -1,3 -1,3 -3,0 ..
Latvia .. 0,0 -4,0 -3,0 -2,0 -3,0 -2,0 Romania 3,6 -2,8 -2,5 -3,6 -3,1 -3,1 ..
Slovakia -5,2 -2,5 -1,8 -3,0 -4,5 -4,8 -4,5 Poland -1,2 -2,4 -2,0 -2,2 -4,3 -5,1 -4,6 Hungary -4,0 -5,5 -3,0 -2,8 -2,7 -8,8 -4,0 Source: WIIW, Bank of Estonia, Central Statistical Bureau of Latvia and Statistics Lithuania.
Government budgets are in deficit in each TE, except in Estonia with a 1,0% surplus (2002 figure). Highest deficits are in Poland, Czech Republic and Slovakia with over 4,5% of GDP.
Also Hungary has a 4 percent budget imbalance, which is relatively high.
The Baltic States are doing well compared to other TEs. Latvia and Lithuania have each moderate deficits of about 2 percent, while Estonia has even surplus in her budget.
Bulgaria seems to be close to budget equilibrium with only a minor deficit (-0,3%) in 2003.
Slovenia and Romania have relatively moderate imbalances in their budgets with about 3 percent deficits (2002). Since the mid-1990’s, Slovenia has shown more discipline in her fiscal policy than Romania.
3.1 Transitional economies as forthcoming members of the European Monetary Union
In order to adopt the euro, Member States have to achieve a high degree of sustainable economic convergence. This is assessed on the basis of the fulfilment of the "Maastricht convergence criteria". The Maastricht Treaty is in essence mostly about the monetary union.
This Treaty stipulates the “convergence criteria” the members must meet to qualify as a member of the final monetary union. These criteria are as follows:
1. Price stability
Inflation in each country concerned must not be more than 1,5 cent above that of the three lowest EU countries.
2. Budgets
No government should run budget deficit beyond 3 percent of that country’s National Income (GDP).
3. National Debt
Public sector borrowing must not build up over the years to exceed 60 percent of a country’s annual income (GDP).
4. Interest rates
The market rate of interest for long-term government bonds of each country must not be more than 2 percent above that of the three lowest EU countries.
5. Currency fluctuation
National currencies must not be devalued two years previous to union and must stay within the narrow bands instituted by the ERM. The fluctuation margins of the ERM are ±15%.
Participation in ERM II for at least two years prior to the convergence assessment is one of the criteria to be met for adopting the euro. With that rule, the final market value of every EMU-member currency is measured in the managed floating manner (according to ERM rules). This method is obviously supposed to deliver some objectivity in the irrevocable fixing of the exchange rates (ER).
